The sole trader route may be the preferred pathway for many running a business, but there are definite advantages to be gained by operating as a limited company (which are anything but limited).
According to the latest stats over at Companies House, there’s a shade more than 3.6 million incorporated companies in the UK and roughly 92% of them are active.
In 2014, HMRC commissioned Ipsos MORI to do some research (PDF) among micro-businesses to find out what factors motivated them to incorporate in 2010/11. Here are the three main reasons limited company incorporation was given the nod over sole trader status.
Protection through limited liability
Taking calculated risks is part and parcel of doing business, whether you’re a sole trader or a limited company, but only the latter insulates you from a calculated risk gone wrong. The former will leave you out in the cold!
Since time immemorial (well, 1897), the law has said that a limited company has its own legal personality, which is separate from the people who make up the company itself. This means that third parties, such as clients and suppliers, enter into contracts with the corporate entity rather than individual directors and shareholders.
The huge plus point of this legal distinction is that, if you run a limited company as a director, you have limited (capped) liability for its debts, which normally works out at the amount you paid for the shares coupled with any unsecured loans made to the company.
So, if the company runs into trouble or even goes belly-up, you won’t be personally responsible for any of its financial losses. One exception to this rule is if the company’s creditors lose money through fraud you committed as a director, in which case you will incur unlimited personal liability.
By contrast, sole trader status affords no protection from financial claims if a business goes south, because a self-employed person and their business are treated as a single entity for tax and admin purposes. They have potentially unlimited personal liability for their business debts and, in certain circumstances, even their homes may be on the line.
Tax and National Insurance efficiency
Given Benjamin Franklin’s quote that there are only two things certain in life – death and taxes – any opportunity to lower tax payments is always a welcome one.
As a director of a limited company, if you take a small salary and most of your income is in the form of dividends, you’ll still be entitled to State Benefits without paying any employer or employee National Insurance Contributions (NICs). Dividends attract less tax than salary and aren’t subject to NICs, whereas a sole trader’s entire income is subject to NICs.
With a limited company, higher take home pay is clearly the order of the day. However, the Summer Budget 2015 announced a revamp of the dividend taxation system from April this year, which will see limited company shareholders facing higher taxes.
Improved reputation / credibility
Confidence is critical in business and a limited company has a veneer of professionalism, which instils confidence.
While some clients simply prefer to work exclusively with limited companies, others flatly refuse to deal with unincorporated businesses. So, having a limited company can present new business opportunities that may not otherwise have existed.
Other advantages of limited companies include:
Easier access to finance
The separate legal entity of a limited company may make it slightly easier to secure finance than sole traders. Also, companies can raise capital by issuing new shares – to shareholders, new investors, anyone really except Joe Public (only public limited companies can do that).
On the other hand, sole traders normally have to raise new capital from their personal resources. If they happen to be cash-strapped at the time, then that’s pretty much that.
Securing a trading name
Once you register a company with Companies House, the company name is legally protected, which means there can only be one company in the UK with the same name (or anything too similar). The trouble is, as a sole trader, someone else can use your trading name and you are powerless to stop them. Worse still, if they’re into dodgy dealings (think Cowboy Builders and Rogue Traders), this could hurt your business to no end and put you to the stress and inconvenience of having to change your trading name and potentially lose all the hard-earned brand recognition that you built-up over the years.
Protecting a trading name for a future business
Let’s say you have a lightbulb moment with an inspired idea and name for a business, but you’ve neither the time nor the capital to develop it just yet. Instead of abandoning your idea altogether, you can set up a dormant company to put the business on hold and protect its trading name at the same time. In the eyes of HMRC and Companies House, a dormant company is one that doesn’t trade and has made no significant accounting transactions during a financial year. In this way, a dormant company can protect future interests.
Easier to sell / transfer business ownership
If you want to call it a day, sell your shareholding or (heaven forbid) you go to meet your maker, it’s much easier to transfer ownership of a limited company than an unincorporated structure.
If these advantages have piqued your interest somewhat and you want to start a limited company as your business structure of choice, you can wrap up the entire process online in just a matter of hours (Companies House has a rapid-fire turnaround and approves most applications within three hours).
A limited company isn’t for everyone, but its advantages are aplenty.
Download the free guide
Want to know more? Download our free guide to setting up a limited company.
You’ll learn what taxes limited companies pay, what to do about business insurance, how to optimise your wage using salary and dividends, and much, much more.